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Work needed to ease sovereign debt concerns globally
Despite the pandemic, the world economy has so far been able to avoid a systemic global crisis. Key architectural changes must be made to sovereign debt to keep it that way
As global debt levels continue to rise, so
too do concerns that a systemic crisis will be unavoidable if certain steps are
not taken to better-manage sovereign debt.
The Covid-19 pandemic is seen as a final straw for certain countries as
they struggle to cope with the economic stress brought on by the pandemic, and
debt levels rise insurmountably.
Four years ago, the
IMF’s fiscal monitor calculated that total global nonfinancial debt
amounted to $152 trillion, or 225% of world GDP, while public debt increased by
15 percentage points of GDP between 2000 and 2015.
“As the pandemic raged throughout the
world, debt turned out to be a very serious pre-existing condition. All
countries face the same crushing combination: higher spending to fight the
disease and protect people; and lower revenue because of the recession
triggered by all necessary containment measures,” said IMF first deputy
managing director Geoffrey Okamoto, at the Peterson Institute for International
Economics Conference last month.
See also: Sustainable finance will emerge stronger from Covid-19 rebalancing
“Compared to pre-pandemic expectations,
median debt in 2021 is projected to be up by about 17% of GDP in advanced economies;
12% in emerging economies; and eight percent in low-income countries.”
Collective
action
Last month, IMF staff released a paper
that took a deep dive into these issues and how they can be resolved.
It found that while the sovereign debt
space faces significant challenges, there are reform options and sector
policies that could improve contractual frameworks. One such policy would be to
encourage the increased use of state-contingent debt such as natural disaster
clauses.
“In terms of official sector policies,
consideration should first be given to increased use of state contingent
instruments, particularly to protect debtors against downside risks. This debt
can be used much more broadly,” said Ceyla Pazarbasioglu, director of the
strategy, policy, and review department at the IMF.
“This is particularly relevant during the
pandemic and due to the extreme uncertainty both in terms of health and
economic developments. Such instruments, in theory, can help avoid protracted
negotiations between creditors and debtors over recovery values, and
potentially even relapse into default post-restructuring.”
See also: Ecuador buys time with aggregated collective
action clause
However, these instruments provide upside
to creditors – such as GDP link warrants – and have rarely been used in in practice.
These are heavily discounted equity-like instruments, because of their non-standard
designs, as well as their illiquidity
and idiosyncratic risk profiles.
Other policies include encouraging greater
debt transparency and developing debtor countries’ debt management capacity.
The paper also strongly suggests promoting wider
adoption of enhanced collective action clauses (CACs).
Peter Orszag, CEO of Lazard, said that the
importance of the IMF and its endorsements and role as a broker is crucial in sovereign
debt markets around the world. As such, work must continue in the bid to reform
and strengthen the provisions that have led to the successful resolution of recent
sovereign debt crises, such as the one playing out in Argentina.
“For future progress it’s important to
emphasise the importance of CACs, within which we should focus on the single
limb mechanism – which is yet to be tapped – to explore whether we need to
reduce the threshold or not,” he said. “Secondly, some thought should be given
to the so-called uniformly applicable condition that applies when that
approached is deployed, that requires certain constraints on the menu of
options presented under that aggregation method, and might impede the use of
that mechanism.”
“There are other ways of ensuring equity for
creditors that might not be the same as what is currently allowed,” he added. “You might
think that making the CAC stronger would increase the cost of capital, but there
is at least some evidence that it might cut in the other direction – so that
bonds with enhanced CACs trade at a premium, with lower yields than other bonds.”
See also: Report on Covid-19 assigned social bonds
More
is less
Panellists agreed that the very nature of
the way sovereign debt is structured needs fundamental reform if debtors are to
be protected; a problem given extra urgency by the economic impact of the
Covid-19 pandemic.
“The architecture of sovereign debt management looks more and more like it was made for a world that doesn't exist anymore, it is premised on a lot of bright lines that may be administratively necessary but just aren't tenable,” said Anna Gelpern, professor at Georgetown Law and nonresident senior fellow at PIIE. “The line between official and commercial debt is unbelievably blurry and always has been, official and commercial creditors likewise."
She added that domestic and external bonds
and loans look increasingly similar, which means that loans should have the same
contractual matter that bonds have. “This is really not a this clause or that clause
conversation. This is more a bonds, loans, funds and banks are looking awfully
similar now. So what do we do about that?”
However, as more countries access financial
markets, and there are more exogenous shocks like pandemics and climate events,
some typically low-income country problems look like old middle-income country
problems. “I’m not sure we necessarily have the capacity to address that,” said
Gelpern.
To remedy this issue, she recommends
resolving issues with equity, transparency, and diversity.
See also: Kingdom of Thailand's sustainable bond first explained